The Bitcoin Taxman Cometh: Calculating How Much Crypto-Investors Owe IRS Could Be Easy

With April 15 just weeks away, the IRS dropped its long-awaited "virtual currency guidance," decreeing that cryptocurrencies such as Bitcoin will be regarded as property rather than currencies. "In general, the sale or exchange of convertible virtual currency, or the use of convertible virtual currency to pay for goods or services in a real-world economy transaction, has tax consequences that may result in a tax liability," says the notice from the IRS.

"Purchasing a $2 cup of coffee with Bitcoins bought for $1 would trigger $1 in capital gains for the coffee drinker and $2 of gross income for the coffee shop," translates Bloomberg.

All those people who rode the Bitcoin rollercoaster last year, who bought in at $13 and then sold (or spent) their Bitcoin when it topped $1,000, will need to use some of their profits to pay an accountant, because H&R Block's free tax software isn't going to do the trick. At least one entrepreneur sees opportunity here that would take advantage of the public nature of Bitcoin activity.

"Accountants are going to want a very accurate transaction history and value of Bitcoin at the time it was purchased and used or sold," says Jake Benson, 25. At least one Bitcoin tax service -- Bitcointaxes.info -- invites users to manually enter their Bitcoin trades to calculate taxes, or to import it their trading activity from their chosen wallet service, such as Coinbase, Bitstamp or (eek) Mt. Gox. Founder Colin Mackie, a Seattle-based software engineer, started the service after he realized he needed it himself. "I was trying to calculate my own taxes [this Christmas], opened up Excel, and realized that was going to be impossible," he says via chat. "So I started writing something."

He says that approximately 400 people have used the site since it launched in February. That was before the guidance from the IRS came out; now he plans to update the service to incorporate the self-employment tax that Bitcoin "miners" are expected to pay, per the new guidance. Mackie says that 4,000 people visited his site the day the guidance came out, which is a "lot more" than usual.

But Benson says tracking Bitcoin trades could be even more automated. He launched Libra Tax in December, incorporated it weeks ago, and says he found an angel investor (today coincidentally). A responsible taxpayer would simply plug his or her Bitcoin wallet addresses into his service. Because Bitcoin is one huge public ledger, the service could pull data about all the Bitcoin that moved in and out of the wallet, automatically compute the value of the Bitcoin at the time, and calculate the tax burden. Users will be able to decide which exchanges they want to use to value the Bitcoin (Mt. Gox or Bitstamp or BTC-E...) and whether they want to "cash in" the first bitcoins they bought (the ones from years ago purchased for $2) or the last ones in (in case they want to claim capital losses for those purchased in November for $1,100).

Sounds great! Unfortunately, it's not built yet.

For the past three years, Benson has been an IT consultant for Cap Gemini in Austin, Texas. He left the firm just this year to start working on the start-up full time. Benson expressed surprise that the IRS guidance arrived already; he thought it would take "years." "I plan to launch in September," says Benson. "I'll be operational in time for those who file for a tax extension."

Benson has already thought through some kinks, though he still needs to bring a certified public accountant on board. Users will be able to flag some transactions as non-taxable, say if they were transferring a bitcoin from a Coinbase wallet to a Blockchain wallet. Otherwise, that would look like one bitcoin being "cashed out" and another being bought.

Jake Benson, Libra Tax founder

For those worried about anonymity and associating themselves with their wallet addresses, Benson says users will have the option to upload a file with a history of their transactions -- though, given the public nature of the ledger, that seems like an imperfect solution to preserve anonymity. Regardless, the government will still have a list of all the people using Bitcoin if they pay taxes on it.

"Super libertarians and anarchists who love Bitcoin's anonymity aren't going to pay taxes any way," says Benson. "As the Bitcoin system matures and the community grows in legitimacy, I think the emphasis on its anonymity will decrease."

Investor Marc Andreessen put it another way at a Bitcoin conference Tuesday morning, saying that the public nature of the Bitcoin blockchain (and the government's appreciation of that transparency) will cause the hard-core libertarians who were Bitcoin's early promoters to "turn on it."

After all, the same transparency that would make tax preparation easy could make it easy for the IRS to see who's not paying their taxes.